The Oil Drum

By looking for headlines in the world's main media, the ECB tries to prevent a panic. It also gives off a signal, though, that it's afraid such a panic might ensue.

That's exactly the issue - emergency liquidty injections are very much a double-edged sword. They play out differently depending on the mood of the market. (See the quote I added to my comment second from the top on the reaction of the market today.)

And these two quotes from the Bloomberg article are scary:

This is an old-fashioned credit crunch,'' Chris Low, the chief economist at FTN Financial in New York, said in a report today. ``This is not a small thing. A credit crunch, when the short-term credit markets seize up, is extraordinarily serious, almost always the precursor of a significant recession.'

Somewhere out there, there are several people that are in trouble -- it's hard to put your finger on it,'' said Andrew Busch, global foreign-exchange strategist at BMO Capital Markets in Chicago. ``I cannot name names. We know BNP has issues with three funds. But you do not see a movement in overnight rates like that unless there is a huge concern about liquidity and funding.''

Triumvirate of collapse - Economy, Ecosystem, Energy

BNP Paribas's Chief Executive Officer Baudouin Prot said the bank's exposure to U.S. subprime was ``absolutely negligible'' when the company reported a 20 percent increase in second-quarter net income last week. BNP Paribas Investment Partners oversees about 356 billion euros.

Hahahaha!

Just yesterday with the DOW back up to 13,600 CNBC was celebrating BAU with those pesky subprime problems behind us. "The stock market has gotten beyond them now".
The bull market sentiment still has a long way to go though. The PTB have instilled a very deep sense that things will always get better again. So all this noise about credit and liquidity problems is nothing but a buying opportunity.

-Don

NC,

The Federal Reserve is restricted and cannot buy private securities (mortgage debt). This is the job of Fannie Mae and Freddie Mac -- gov't "sponsored" enterprises (originally) to help finance mortgages and promote homeownership which the government wanted to promote. Later they were "privatized" into companies.

There was a "rumor" printed in the Financial Times recently that Fannie and Freddie are going to be authorized to buy sub-prime (which they currently don't). Offically, I think, Fannie and Freddie are "private", but hardly anyone in finance thinks that they would remain strictly "private" in a mortgage debacle. I think they have their own regulator (OFHEO is it?).

Anyhow, the government/politicians will step in once people are shown on TV getting booted out of homes, re-federalize Fannie and Freddie (turn them back into "Federal National Mortgage and Federal Home Loan or whatever they were called"), and buy sub-prime mortgages, and eat the losses -- that's what the government is for! -- the ultimate bag holder! (note to libertarians: this is where libertarian policies go astray).

Exactly. Halliburton is certainly winning, and so are many other defense related contractors.

Damn...I wish I owned a bank and could get all the free money I needed.

And so Don you describe my worst fear but also what I consider to be the most likely outcome - an inflationary cycle to destroy consumer and government debt.

Stoneleigh has often discussed deflation where holding cash makes sense - is it possible we see defaltion first followed by a mega-inflationary phase?

And during inflation what best to own? - I'm currently thinking land a real estate - and hang the fact they look over priced - you still own em and they are durable - so long as title is backed by a robust legal system like we have in the UK.

And how's the sailing going? You been over the pole yet?

In an inflationary scenario, would China start selling off USD? Earlier this week, in the Telegraph, a high ranking Chinese politician and an academic suggested that:

the Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar

Don, it's clear that the Fed (and the ECB) has the power to inject whatever amount of liquidity they wish into the market and thus prevent deflation and more generally achieve the level of inflation they wish. What's not clear to me is the wisdom of doing that this time.

In 1987 (and still in 2001, though to a much lesser extent) the world economy was far from any physical "limit to growth", so it made sense (at least for the short run, the only timescale that matters for Keynesians, because in the long run...) to assure the markets that financial conditions would not be allowed to put a brake to economic growth.

But now, according to the IEA, the world is definitely about to bump against one such "limit", namely stagnant oil production rate. Specifically, the June report predicted Q4 stocks withdrawals of 2.1 Mbpd and the July report predicts Q4 stocks withdrawals of 2.3 Mbpd. That's unprecedented and would send the oil price skyward. They also stated in the recent Medium Term OMR: "it is abundantly clear that if the path of demand does not change on its own, it may well be driven to change by higher prices." Therefore we are now in a fundamentally different position from that of 1987 or 2001: while letting the credit crunch proceed would reduce oil demand and economic activity in general by way of recession, injecting monetary stimulus would send the oil price higher which in turn would also curb demand and economic activity.

Using the car analogy, it might make sense to press the brake when you have little fuel left, so as to better control where, when and how the car stops.

But there is a much more powerful reason to allow the credit crunch to proceed: viewed from Hubbert's Peak, a substantial part of American economic activity - and probably the most sensitive to tight financial conditions - is not positive or even neutral: as often stated by Kunstler, by way of suburban construction the US is just digging itself into an ever deepening hole, what with the loss of farmland becoming a critical issue due to biofuels. So if a credit crunch is the only way to stop suburban construction, LET IT BE.

Using the Easter Island case as a model for today's economy, if tight monetary conditions will play the trick of stopping the extremely unwise activity of statue carving, transporting and setting up, just don't loosen them.

So, while a bit of research may show up an old post of mine where I stated my view that "the Fed will follow a path that will ensure that existing debts will be gradually melted away by inflation, so as not to add insult to injury to the majority of the American population who is in debt and will already be feeling the painful effects of the decline in oil and gas production", with a better understanding I now hope that will not be the case, for the same reason you should not give money to an addict.

Thus, while I agree that the Fed (and the ECB) has "the tools" to keep the ship going full steam, I hope it will not have "the will", because such flat-earth-economics-enlightened "leadership" would be ruinous. The wise way to navigate rough waters is to slow down when you have an iceberg in front.

Don,
Haven't you only presented half the picture here (from which people here are only seeing the inflation side)? The Fed is buying gov't instruments, but still expects payments on those instruments. If there is no default, then might taxes be raised to make the payments, which is deflationary. And once the crisis is abated, the Fed may liquidate some of its holdings, etc. This picture is much more complicated than just "printing money" out of thin air. The new money often ends up getting un-printed in short order.